MacroScope

Finally, an Italian government

A weekend packed with action to reflect on with more to come.

Top of the list was the formation (finally) of an Italian coalition government. Market reaction is likely to be positive, although Italian assets rallied last week, and today’s auction of up to 6 billion euros of five- and 10-year bonds should continue this year’s trend of being snapped up by investors. Italian bond futures have opened about a third of a point higher.

Prime Minister Enrico Letto will seek a vote of confidence in parliament at 1300 GMT, which presumably should go without a hitch. But a coalition with the centre-left and Silvio Berlusconi does not necessarily look like a recipe for smooth government. It is quite possible that the leftward part of the centre-left will find it too hard to stomach, eventually leading to a split. Letta is expected to try to pass at least a few basic reforms quickly including a change to Italy’s much criticised electoral laws and a cut in the size of parliament

As far as the markets are concerned, there shouldn’t be any nerve-jangling economic policy shocks although Letta has said debt-cutting is self-defeating. New economy minister Fabrizio Saccomanni said on Sunday he plans to cut taxes and public spending and lower borrowing costs. The rhetoric may have shifted but the reality for the euro zone’s high debtors is many more years of pain to come. But it’s probably true that more emphasis will now be placed on structural reforms.

German Finance Minister Wolfgang Schaeuble meets his Spanish counterpart, Luis de Guindos, in southern Spain and may have some goodies on offer. Last week, he hinted that he would support a joint programme to boost investment in small- and medium-sized companies – the fabled SMEs. Irish premier Enda Kenny will be there prior to flying to Lisbon. The European Central Bank is also looking at how to get credit flowing to smaller companies, although there is some internal wrangling about whether that is the work of a central bank. It’s interesting that Berlin is prepared to act bilaterally and the word is that similar mechanisms could be rolled out elsewhere.

Germany, despite standing firm against rhetoric suggesting the age of austerity is over, also appears content to see Spain and others in the euro zone get a year or two longer to meet their deficit targets. This begs two profound questions. Does this suggest Berlin is loosening up a little as its economic data suggests even it is struggling? And does acting bilaterally denote a loss of faith in the European Commission?

The pain in Spain … spreads to Italy

This morning, we exclusively report that Spanish Prime Minister Rajoy could be about to break another promise by freezing pensions and bringing forward a planned rise in the retirement age.

This latest austerity policy will be political poison at home but will give Madrid more credibility with its euro zone peers since that was one of Brussels’ policy recommendations for the country back in May. We know that at the end of next week the government will unveil its 2013 budget and further structural reforms which all smacks of an attempt to get its retaliation in first so that the euro zone and IMF won’t ask for any more cuts if and when Madrid makes its request for aid.

The pensions shift could well be kept under wraps until regional elections in late October are out of the way. It is less likely that the government can defer a request for help from the euro zone rescue fund, after which the ECB can pile into the secondary market, for that long given some daunting debt refinancing bills falling due at the end of next month.